You've seen it happen and wondered how your neighbor did that. He sold his home by owner financing it but you KNOW that he has a mortgage on the home. How in the world can he sell something and NOT pay it off first?
There is an alternative way of seller financing called a "wrap-around mortgage." A "wrap" leaves the existing mortgage in place when the property is sold and a new wraparound note is created between the buyer and seller. In simple terms, the seller is now acting like a bank that loaned money to buy a home.
How does it work? The buyer puts a down payment on the home, and the seller makes a note to the buyer for the balance. The wraparound note is secured by a new deed of trust and becomes a "junior" lien on the property (junior to the existing lien). The buyer makes monthly payments to the seller on the wraparound note and the seller makes the payments on the original note to the lender. Usually, the wraparound note that the seller secures with a buyer exceeds the seller's current mortgage on the property; thereby allowing the seller enough funds to make his/her monthly mortgage payments to the lienholder.
Alternatively, the seller can secure the services of a note servicing company to service the note which could be an easier and cheaper way to collect payments; that company will collect and disburse the underlying existing mortgages but also any additional notes and associated expenses involved in the transaction such as paying the property taxes, insurance, and HOA dues. The costs are surprisingly reasonable ranging from an initial set-up fee of $25-$35 plus a monthly fee of $15-$30. The seller can also charge this cost to the buyer of the property as an expense for owner financing. Some note servicing companies may also report payments to the 3 major credit bureaus which can help your buyer's FICO score greatly. Those companies costs are a bit more but well worth it in the long run because once a buyer establishes a good payment history on the wraparound note, they will likely be able to refinance sooner thereby paying your note off faster!
The interest rate on the wraparound note is typically higher since seller financing usually carries a rate higher than market. The wraparound note is usually amortized for a shorter time period, i.e. 15 versus 30 years, and also balloons (come due in full) from 3-7 years.
The wraparound transaction is handled very similar to a normal purchase. The addendums for a seller financed transaction will be different however; the buyer submits an earnest money contract along with a seller financing addendum that spells out the terms of the wraparound note.
When the wraparound note balloons or anytime before; the buyers can refinance the wraparound note. The original mortgage is paid and released. The seller keeps any money over and above the payoff and closing expenses. The main difference between a wraparound note and a conventional loan is that the seller must wait until the wraparound note balloons or when the buyer refinances in order to get paid the full amount of the sale.
Title insurance is available with wraparound mortgages. Closing will be held at a title company. The buyer will receive title insurance with the existing lien as an exception.
Wraparound transactions are helpful for both buyers and sellers. With stringent lending guidelines in today's market, buyers are able to purchase a property while they are working to improve their credit score for refinancing. Sellers are able to receive a substantial down payment from the sale of their property and also monthly income payments until the buyer refinances. More importantly, the seller will likely be able to sell his/her home faster in this market through seller financing because of the demand for this type of financing in today's economic climate.
Sellers that are interesting in selling their homes through this method should do their research about seller financing an existing mortgage, hire an attorney to handle the paperwork for this transaction and/or find a REALTOR that knows how to conduct these types of transactions. Then, be on your way to the next stage of your life with a little money in your pocket!